Student loan forgiveness could temporarily affect your credit — but that doesn’t mean you should worry about it.
President Joe Biden’s plan will forgive qualifying borrowers up to $20,000 in student loan debt. If you’re entitled to forgiveness, the plan can put thousands back in your pocket. But alongside the benefits of lowering your monthly payments and potentially paying off loans faster, there’s at least one downside worth knowing, albeit temporary.
Your credit score could be negatively affected as some rating factors are affected by changes to your accounts. Luckily, this only affects your score for a short time. What’s more, you won’t see your score drop until your credit accounts are closed – meaning you won’t be affected if you owe more than was forgiven.
“You might experience a small dip in your score, but that’s not something I’d worry about because over time it will recover,” says Beverly Harzog, credit card expert and consumer finance analyst for US News and World Report.
Here’s exactly how student loan forgiveness can affect various factors that go into your credit score and how you can maintain excellent credit despite short-term losses.
How a credit waiver can affect your score
Student loan forgiveness largely affects three factors that make up your creditworthiness, or ability to apply for loan products: mix of credit, age of account history, and debt-to-income ratio.
However, credit profiles and their associated scores are complex and personal, so it can be difficult to generalize about how student loan forgiveness will affect everyone’s scores, says Justin Hakes, vice president of communications at the Consumer Data Industry Association. “Removing or pausing information about student loans from credit reports clearly impacts consumers’ credit scores.”
It largely depends on how the various credit scoring factors relate to your individual credit history.
Age of credit history
The longer you have a credit history, the better. And for many Americans who took out student loans as young adults entering college, those loans may be the oldest accounts on their credit reports.
The age of your credit accounts isn’t the most important factor in your score — it accounts for about 15% of your FICO credit score — but it can be impacted if your accounts are closed, especially the oldest ones.
However, the drop is temporary, and paying off your loan in full makes any temporary drop in credit worthwhile.
Credit mix accounts for 10% of your FICO credit score, although it may be the factor most affected by student loan forgiveness.
Student loans (among other personal loans with regular payments over a period of time) are a type of installment loan. On your credit report, installment accounts are different from revolving accounts, such as B. a credit card or home equity loan (HELOC). In general, having a mix of installment and revolving account types helps your score.
If student loans are the only type of installment loan account on your credit report, closing them could result in a major drop in your credit score. However, if you have another installment loan, like a mortgage, car loan, or personal loan, you won’t see much of a change, according to Harzog.
Many borrowers have more student loan debt than the $10,000 forgiveness limit (or $20,000 for qualifying Pell Grant borrowers). Your credit mix is only affected when an account is closed. So if the edict isn’t enough to close your student loan account, you don’t have to worry about the impact on the loan mix until you’ve paid off your loans in full.
Debt to Income Ratio
The credit impact of student loan forgiveness is not all negative. In fact, canceling thousands of dollars of debt can also improve your score — increasing your chances of being approved for more types of credit or loans in the future.
That’s because a lower debt level can improve your debt-to-income ratio (DTI), or the amount of your income used to pay off your debt each month. The lower your DTI, the more attractive you will look to a lender as you will have more income available to take on new debt, such as debt. B. a mortgage payment.
How Student Loan Forgiveness Won’t Affect Your Credit Score
With all the credit factors that are affected by student loan forgiveness, there are also some important reasons why it doesn’t make a difference.
The two most influential evaluation factors
Payment history and credit utilization are the most important factors in determining your credit score — together they make up 65% of your overall FICO score. For the most part, student loan forgiveness doesn’t have much of an impact on either of these factors.
Payment history looks at your records of recurring payments on all your open accounts on time and in full every month. However, missed or late payments will adversely affect your payment history. While not affected by a loan forgiveness, it’s a good idea to make a plan for any remaining loan payments you still owe before the moratorium is lifted in early 2023.
“Paying bills on time is the most important thing,” says Harzog. “If you still have a student loan to pay off, pay it conscientiously, pay it on time. This helps build and improve your credit score.”
How credit utilization — or the ratio of existing debt to your available credit — goes into your score is much more dependent on how you use credit cards, Harzog says. Installment accounts don’t count toward utilization, but you can maintain good credit by keeping credit card balances low.
Past credit failures
Missing or late payment can negatively impact your credit score. If you have made a mistake with your student loans in the past and it has been reported on your credit, student loan forgiveness will not erase it.
“He will stay there for seven years,” says Harzog. “Everyone makes a mistake once in a while… If it’s right, you can’t scratch it off your credit report and you just have to wait it out.”
These reported errors also tend to have less of an impact the further away you are from the date they appeared on your credit report, she says. “Just swear to have great future credit habits and eventually your score will bounce back.”
Note that this does not apply to the student loan payment pause in response to the pandemic. These missed payments will not negatively affect your score as long as you start paying the balance when the pause is lifted next year.
At the end of the day, paying off a large chunk of student loan debt is worth the relatively small — and temporary — impact on your credit score.
“It’s nice for people who qualify. But I don’t think that will suddenly bring your score up or down in any drastic way. And in the next three to six months it will probably even out anyway.”
The key to good credit is to consistently practice good credit habits over time. Paying off your account balance in full and on time each month—while not spending more than you can afford—can help you build and maintain great credit.